Goodrich Petroleum: Dominant Player in a Brand New Shale

The biggest player in a nascent shale

There's been a tectonic shift in oil and gas production over the past three years. New technologies like horizontal drilling have yielded major discoveries in what many experts believe to be the deeper "source rock" for the world's oil. The Eagle Ford, the Bakken and the Marcellus are all brand new oil and gas fields brought about by shale rock discoveries. These new fields represent opportunities for tremendous production growth and will change the face of oil and gas production over the next couple decades.

How can we invest in this huge opportunity? Tied to other assets and lacking maneuverability, US "supermajors" have largely missed out on the shale. Chevron(NYSE:CVX), for example, seems to have bet more on deepwater production. In any case, investors interested in the shale growth story must look to other names. There are some larger names in the shale, most notably EOG Resources(NYSE:EOG) with its fantastic acreage in both the Eagle Ford and Bakken. I believe the best way to take advantage of the shale, however, will be in small- or mid-cap companies in new shales or with very high growth.

One of these names is Goodrich Petroleum(NYSE:GDP). Goodrich is a small-cap oil and gas producer that operates on a few properties in Louisiana and Texas. Its biggest acreage position by far is in the Tuscaloosa Marine Shale in Southeast Louisiana, a still untapped shale play which is part of the same formation as the Eagle Ford in South Texas. As the biggest company in a brand new shale, we could be looking at an opportunity similar to that of the Bakken in 2010 or the Eagle Ford in 2011 (though likely not on the same scale).

If initial well results in the Tuscaloosa are any indication, returns will be similar to both aforementioned shales, maybe better: Goodrich is witnessing internal rates of return at 50%-60%, a number which will surely go higher as servicers flock to the area and infrastructure gets built and well costs come down. And so far, production has been at least 90% oil. The Tuscaloosa is looking like a very oily play.

With net acreage at over 320,000, Goodrich's position in the Tuscaloosa is truly dominant. Up until the beginning of this year Goodrich had only 200,000, but Devon Energy decided to concentrate on other geographies and sold its entire Tuscaloosa position to Goodrich for a very reasonable price. With such a huge position, much of which was acquired at a low cost, Goodrich has the potential to soar as the Tuscaloosa comes online, but it does need to clear a few hurdles and execute on a few fronts.

Well economicsThere are only a few test wells operational in the Tuscaloosa at this point, and we can't judge the whole shale from just those few. However, what we do see is pretty amazing. Encana's nearby Anderson 17H-1 well has a production curve right between the average Bakken and Eagle Ford well, meaning it produces about as much as an average well in those shales. The Anderson 18-H well has an even higher production curve than the average: In twelve months it is slated to produce more than 130,000 barrels of oil equivalent, at least 90% of which is oil.

One downside is that the Tuscaloosa's oil is deeper than the Bakken's or Eagle Ford's. Drillers have to dig at least 10,000 feet under to get to that shale oil. This, coupled with the brand new nature of this shale, has put Goodrich's average well cost at $13 million. By comparison, the average Eagle Ford well is around $7 million to $7.5 million. Goodrich believes it can bring that number down to $10 million per well by the year's end, but it's still very high.

As the oil world gets wind of the commercial viability of this shale (and all signs thus far have pointed to it being viable), servicers should steadily enter this shale, which should bid down the high service costs that exist right now. Also, transportation infrastructure here should improve over the next 18 months or so. Both of these factors should further reduce well costs, making Goodrich's wells just that much more profitable.

Production growthIn 2013 Goodrich is on schedule to boost its oil production by between 30% and 40%. Actually, much of this year's growth is coming from its smaller Eagle Ford holdings. Next year will see a big shift in capital spending toward the Tuscaloosa as management believes that acreage has more potential. Goodrich is one of the few oil producers that will see accelerated oil production growth.

Bottom lineYes, the stock has more than doubled in just this summer, and it now trades at over 7 times book value. But if ultimate recovery rates in this shale are similar to the Eagle Ford or Bakken, we can expect Goodrich to soar even from today's levels. Why? Because this is now easily the dominant player in an untapped shale. In fact, its position here is akin to EOG's in the Eagle Ford, which is now a $46 billion company. Yet, Goodrich's market cap just recently broke $1 billion. This one could have a long way to run.